Economic Undertakings

Public sector banks – the promise of a new dawn

After much deliberation, India has finally bit the bullet of public sector bank (PSB) consolidation. The expected benefits in terms of cost reduction thanks to improved efficiency and better quality of service, risk diversification and a larger balance sheet allowing the possibility of issuing larger checks without constraint by the exposure limits of ‘a single borrower and a single group are evident.

In tune with the growing demands of the Indian economy and its aspirations, there is a requirement for banks whose balance sheets are capable of underwriting large projects. Currently, the State Bank of India (SBI) is the only bank in the top 100. To put this in context, the size of the SBI’s balance sheet was around $ 600 billion (in FY21), compared to $ 5,000 billion for industry and commerce. Bank of China.

Internal expertise

A large bank is likely to have strong internal expertise and experience to assess and assess risk. During the last phase of growth, most of the smaller PSBs were followers who took exposure with the aim of expanding their balance sheets, without necessarily having a clear understanding of risk. In this regard, the comments of the Minister of Finance for India needing 4-5 SBI-sized banks are relevant.

It has been about two and a half years since the first merger of three large banks (Bank of Baroda, Vijaya Bank and Dena Bank) and a year and a half in the following ones. While it may be too short to analyze the results, given that almost an entire year and a half has been under the shadow of the pandemic, our assessment shows that the first signs are encouraging.

The merger process went smoother than expected. While there were protests from employee unions, the right message from the government and bank management helped to limit their intensity. The fusion schemes were well thought out and the compatibility of the system was taken into account when selecting the candidates. This allowed for a smoother transition of customers and departments from the merged bank to the anchor bank. The merger of the banks resulted in a much higher deductible, which should promote risk diversification. The five merged banks, along with SBI, now account for 53 percent of system advances (FY21) compared to 44% in FY19.

Merged banks are also likely to reflect better risk diversification as they demonstrate discretion and risk-adjusted pricing when taking exposure, which should translate into a lower concentration of advances. They would also have enhanced negotiating power with borrowers and a better ability to assess risk. As one might expect, a large part of the asset quality issues in the corporate segment arose due to weak bargaining power, as banks would often be content to participate in the loan consortium on finalized terms. by the big banks, thus losing both prices and collateral guarantees.

Consolidation is also likely to strengthen funding as banks may require borrowers to direct transaction flows through them, thereby improving their current account deposits.

Operational efficiency

The merger also helped improve operational efficiency, as overlapping branches were closed, resulting in savings. SBI had closed about 3,000 branches after the merger of its banking subsidiaries with itself in one year. Canara Bank rationalized around 600 branches in one year. Similar steps have been taken by other merged banks.

The elimination of overlapping responsibilities in the consolidated entity strengthened the pool of senior managers of the merged entity. One area consolidated banks should focus on is the upgrading and adoption of technology and digitization, a process that becomes effective with scale. As customers become more demanding and their needs and requirements change, this area is likely to become a differentiator.

Reduce government presence

The second aspect of the reform of the banking sector is the emphasis placed by the government on reducing its presence in businesses and on its role as a facilitator. Some of the PSOs have historically experienced poor operational performance (asset quality and profitability), poor efficiency, and inadequate financial management and governance. These banks are in constant need of government assistance, from taxpayer dollars, to support their operations. There is an argument that private control over these banks would stimulate a healthy and efficient banking system, which would be better prepared to meet the banking needs of a high suction economy, limiting demands on government resources.

The government has already announced that there will be no more consolidation and its intention to privatize two PSBs (yet to be identified). While the idea has its merits, there are some challenges that need to be addressed. PSUs are governed by the Banking Companies (Acquisition and Transfer of Businesses) Act 1970, which caps voting rights at 10 percent for a non-government shareholder, regardless of the participation of private shareholders. The laws would require amendment and would have to be passed by Parliament.

One would think that some large domestic private banks or some foreign banks could be potential suitors. However, private banks have generally been lukewarm about acquiring PSBs, due to challenges related to systems integration, culture and HR policies. In addition, selling the banks’ stake to foreign banks can be politically embarrassing.

This paves the way for the other debated topic of allowing businesses to own banks. Many corporate companies operate large insurance companies and NBFCs and, therefore, have experience in managing a financial services segment.

However, concerns have been expressed about the ability of regulators to extend their oversight to non-financial entities, and the risk that challenges in non-financial entities will seep into the financial services segment. But the main argument has been the prevention of connected loans and banks owned by companies as a neutral intermediary. Apparently, the reason for the nationalization of banks was to prevent the abuse of the banking system by groups of business owners.

Some of these issues may take time to resolve and therefore the privatization process may be a long drawn out affair. That said, there is little doubt that these measures, if implemented, will have enormous potential and can significantly help support India’s economic aspirations.

(The author is Director and Head, Financial Institutions,

Assessments and research in India)

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